The Minimum Wage: silver bullet or poisoned chalice?

In recent months, politicians have urged the Low Pay Commission (LPC) to consider a significant increase in the National Minimum Wage (NMW). In February the LPC recommended an increase of 3 per cent for October 2014, from £6.31 to £6.50, which was accepted by the government. This is a substantially smaller increase than suggested by the Chancellor of the Exchequer, who wanted the NMW to rise to £7 by 2015.

The NMW has risen significantly relative to average earnings since its introduction in April 1999. During that time, the NMW increased by 75 per cent in nominal terms, whilst average earnings have increased by 61 per cent. Even since 2008, the NMW (14 per cent) has increased relative to average earnings (10 per cent), though more slowly than the price level.

The idea the NMW can be safely raised stems from the belief that it has not had a negative effect on employment. The consensus view, however, is that minimum wages at moderate levels have a small negative impact on employment and that the level of the minimum wage matters. A recent HM Treasury submission to the LPC, for example, estimated that raising the NMW to £7 per hour would increase unemployment by 14,000 by 2018/19. There is also evidence of reduced working hours in response to NMW increases. International research suggests many of the negative effects operate after a long time period through reducing new job creation.

Employment impacts of increases in the minimum wage are likely to disproportionately affect the young, the unskilled, the long-term unemployed and those in lower productivity regions. There is evidence that minimum wages lead firms to replace lower-skilled and less experienced younger workers with older workers. The 18-24 year old unemployment rate has risen from 11.5 per cent in April 1999 (when the NMW was introduced) to 17.9 per cent today. And of those unemployed within this age group, the proportion out of work for more than 12 months has risen from 14.4 per cent in 1999 to 31.8 per cent in 2013.

The NMW is not a targeted poverty reduction tool. 46 per cent of those individuals in households defined as in poverty are workless: a minimum wage can do nothing to help them. Whilst many of those individuals currently on low pay would benefit from a NMW increase, many of the beneficiaries of a minimum wage are not in poor households. 44 per cent of low-paid workers are in households in the top half of the household income distribution.

Some people have advocated a substantial increase in the NMW as a means of improving the public finances. However, the evidence suggests any net benefit is small. The improvement to the public finances of raising the NMW to £7 has been estimated to be just £30 million once all effects are considered.

Claims employers are ‘subsidised’ by in-work benefits in the form of tax credits have some truth, but are exaggerated. Nearly a third of all tax credit recipient households do not have an adult in paid employment and a further million households work fewer than 30 hours per week. Reforming tax credits would be a better means of eliminating the degree to which tax credits subsidise the employers of the remaining full-time workers in receipt of credits.

The ‘Living Wage’ is a misnomer for the three-fifths of those earning less than the Living Wage who are working part-time. Statutory implementation of a minimum wage at the Living Wage level could have a significant impact on employment and theviability of firms in a range of sectors. It has been estimated to cost 150,000 jobs, with substitution for older workers meaning 300,000 fewer young people employed.

Recent proposals for the LPC’s scope to be extended would fundamentally change its remit from seeking to set a minimum acceptable wage floor to more inherently subjective aims, such as reducing inequality or assessing wages by sector.

In the absence of a decision to abolish the NMW entirely, we recommend the government:

· commits not to widen the remit of the LPC, which could make it more intrusive for employers whilst fundamentally changing the LPC's aims

· abolishes the minimum wage for apprentices and under 18s

· suspends the minimum wage for all those under the age of 24 who have been unemployed for more than one year, for the first year of employment

· instruct the LPC to regionalise the NMW from October 2015, taking into account regional productivity differentials. The LPC should examine each region on an individual basis, taking into consideration economic conditions and firms' ability to pay, with the main emphasis placed on private sector employment